The President signed the Consolidated Appropriations Act, which included SECURE Act 2.0, on December 29, 2022.

SECURE Act 2.0 has over 90 provisions, some major and some minor; some mandatory and some optional; some retroactively effective and some that won’t be effective for years to come. One difference between the SECURE Act 2.0 and previous retirement plan laws is that many of 2.0’s provisions are optional…that is, plan sponsors are not required to adopt the provisions, but can if they decide that the change will help their plans and participants. This series discusses the provisions that are likely to be the most impactful, either as options or as required changes.

This article and the next one discusses the “optional” provisions that provide significant tax credits for startup plans for small employers. The Senate Finance Committee’s summary of the provision explains:

Section 102, Modification of credit for small employer pension plan startup costs. The 3-year small business startup credit is currently 50 percent of administrative costs, up to an annual cap of $5,000. Section 102 [of the Act] makes changes to the credit by increasing the startup credit from 50 percent to 100 percent for employers with up to 50 employees. Except in the case of defined benefit plans, an additional credit is provided. The amount of the additional credit generally will be a percentage of the amount contributed by the employer on behalf of employees, up to a per-employee cap of $1,000. This full additional credit is limited to employers with 50 or fewer employees and phased out for employers with between 51 and 100 employees. The applicable percentage is 100 percent in the first and second years, 75 percent in the third year, 50 percent in the fourth year, 25 percent in the fifth year – and no credit for tax years thereafter. Section 102 is effective for taxable years beginning after December 31, 2022.

My last post (SECURE Act 2.0 #6 (Part 1)) covered the expanded tax credit for start-up  costs; this one covers the tax credit for employer contributions.

The Tax Credit for Contributions

The Act created a new credit for employer contributions to start-up plans.

The credits are based on contributions to plans (other than contributions to defined benefit plans).

For employers with 50 or fewer employees in the preceding year, the credit is 100% of the contributions made for eligible employees for the first two years, but not more than $1,000 per employee. The method for counting the number of employees is the same as for the start-up cost credit, that is, it includes employees who earned at least $5,000 from the employer. However, for contribution purposes it counts employees in the year for which the contributions are made (while the start-up credit count is for the year before that credit is claimed). And, of course, the credit only applies to contributions made for those employees and allocated to their accounts.

Also, the credit is only for contributions made for eligible employees who earn wages of $100,000 or less in the taxable year for which the tax credit is claimed. That dollar amount will be adjusted in the future for cost-of-living increases. The definition of wages is the same as for Social Security (FICA).

Then, for subsequent years, the credit reduces as follows:  75% for the third year, 50% for the fourth year, and 25% for the fifth year. There are no contribution tax credits after that.

So, for example, if an eligible employer designs its plan to contribute $1,000 to the accounts of its 30 participants who make $100,000 or less, the employer will contribute $30,000 and receive a tax credit of $30,000 (for the first two years, reducing after that), effectively offsetting the cost of the contributions for the first years (and partially offsetting them for the 3 years after that)..

If the employer has 51 to 100 employees, the tax credit for contributions reduces pro-ratably at the rate of 2% for each employee over 50.

As with the tax credit for start-up costs, the contribution credit is not available if the employer has covered substantially the same employees in a qualified plan, SEP IRA, or SIMPLE IRA in the 3 preceding taxable years. However, unlike the credit for start-up costs, this limitation on the contribution tax credit applies only to the first year’s credit. In other words, even in that case the eligible employer will be entitled to the 2^nd, 3^rd, 4^th and 5^th year credits for contributions.

In addition to the tax credits for administrative costs and contribution costs, there is a $500 tax credit for establishing a plan with automatic enrollment.

Concluding Thoughts

It is proven that access to retirement plans increases the financial security of American workers in retirement. While almost all large employers already sponsor retirement plans for their employees, the same is not true for smaller employers.

Congress is aware of this problem and these new tax credits are part of its efforts to provide an answer. The Congressional intent is to encourage the formation of new plans by small employers.

SECURE 2.0 amended an existing tax credit for administrative expenses for start-up plans by doubling its value for employers with 50 or fewer employees. This enhancement, together with the tax credit for plan contributions for newly established plans of small employers, should accomplish that goal. The combined tax credits can make a new plan almost free for the first 3 years and, even after that, a plan sponsor will receive partial credits for contributions for another two years.

The material contained in this communication is informational, general in nature and does not constitute legal advice. The material contained in this communication should not be relied upon or used without consulting a lawyer to consider your specific circumstances. This communication was published on the date specified and may not include any changes in the topics, laws, rules or regulations covered. Receipt of this communication does not establish an attorney-client relationship. In some jurisdictions, this communication may be considered attorney advertising.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Faegre Drinker.